The Good, the Bad and the Ugly

The independent broker/dealer landscape is lately littered with tales of woe—scores of smaller firms have gone up in a puff of smoke over the past two years due to everything from troubled private placements to insufficient net capital. In February of this year, independent broker/dealer QA3 Financial announced it would close its doors following an arbitration related to Regulation D products. Just over a month later, at the end of April, Ameriprise Financial said it would be selling Securities America, its IBD arm, while the firm was in the middle of finalizing a settlement agreement with investors related to private placements. And at the beginning of June, it surfaced that Harrison Douglas, a small IBD of about 28 advisors, would be closing up shop, after the firm was fined $200,000 in a client arbitration.
There are plenty of other examples. Of the firms that had exposure to the troubled private placements Medical Capital or Provident Royalties, at least 21 IBDs have either folded or announced their intent to sell since 2009, according to FINRA and published reports. Five additional firms went bust over the same period after selling real estate deals by bankrupt DBSI, another alternative investment that has rocked the industry. Meanwhile, another 11 IBDs shuttered in 2010 and 2011 for a variety of reasons, including failure to meet net capital requirements or pay arbitration fees.

The independent broker/dealer landscape is lately littered with tales of woe — scores of smaller firms have gone up in a puff of smoke over the past two years due to everything from troubled private placements to insufficient net capital. In February of this year, independent broker/dealer QA3 Financial announced it would close its doors following an arbitration related to Regulation D products. Just over a month later, at the end of April, Ameriprise Financial said it would be selling Securities America, its IBD arm, while the firm was in the middle of finalizing a settlement agreement with investors related to private placements. And at the beginning of June, it surfaced that Harrison Douglas, a small IBD of about 28 advisors, would be closing up shop, after the firm was fined $200,000 in a client arbitration.

There are plenty of other examples. Of the firms that had exposure to the troubled private placements Medical Capital or Provident Royalties, at least 21 IBDs have either folded or announced their intent to sell since 2009, according to FINRA and published reports. Five additional firms went bust over the same period after selling real estate deals by bankrupt DBSI, another alternative investment that has rocked the industry. Meanwhile, another 11 IBDs shuttered in 2010 and 2011 for a variety of reasons, including failure to meet net capital requirements or pay arbitration fees. (For a complete list of imploding b/ds, please visit RegisteredRep.com.)

In fact, it seems like every week, another independent broker/dealer goes under or up for sale because of a bad private placement or other problematic alternative investments. All that turmoil has left a pool of advisors out in the cold, looking for new firms to call home.

Financial advisors who had significant exposure to the bad investments and who have smaller books of business will have to weigh their options carefully. Some b/ds won't touch these guys because of the bad marks on their books and the risk of potential future liabilities. They are like “the walking dead,” says Todd Pack, president of Financial Advisers of America. Recruiter Jonathan Henschen of Henschen & Associates echoes that sentiment: They are “lepers of the industry,” he says. Some will simply exit the industry altogether. But observers say it's probably not the end of the road for everyone. Some will jump to smaller, more obscure firms willing to take the risk; try the call center/salaried model; start their own RIAs; or go into fixed insurance.

Meanwhile, the very best of the orphaned advisors — those who typically had minimal to no exposure to the problematic investments, are large producers and have respectable product and business mixes — should have their pick of high quality firms. In fact, many firms see the current situation as a perfect storm for recruiting and a golden opportunity to get in front of some high-quality advisors who are desperate for new digs. Just a word of advice: If you are one of the good ones, be sure you don't jump from one imploding firm to another. You are likely to be eager to get in the door at a new b/d, but be sure to do some thorough due diligence.

“Sooner or later every advisor will find a broker/dealer,” says Philip Palaveev, president of Fusion Advisor Network. “There are passengers for every train.”

Good Homes For Good Guys

Even good advisors with some exposure to bad investments may find they are sought after. Take the story of one former Securities America advisor, who declined to be named. The advisor remembers when Medical Capital's private placement was introduced at a Securities America (SAI) convention that took place in the summer of 2005. Before introducing it to his clients, he spoke to people at the home office and was assured there were no concerns, so he recommended it. Since then, the Securities and Exchange Commission has charged Medical Capital with fraud, launching a slew of complaints, arbitrations and class actions from clients who were sold the private placements. This FA was one person on the other end of those complaints.

But don't worry for him too much; he recently landed at a top IBD in the industry. He says he was honest with the new firm about the SAI situation and about potential lawsuits to come. In addition, it was the only black mark against his name — he'd never had any other customer complaints — and the fact that he was producing over $500,000 a year didn't hurt either. While he was shopping around, the majority of b/ds realized that the Medical Capital fiasco wasn't a broker problem, but rather a b/d problem, he says.

“To the extent that some of these market conditions — or I should say the environment in which these independent firms operate — becomes more difficult and these firms exit, it's a target-rich environment for recruiting, so it's a good thing,” says Larry Roth, president and CEO of Advisor Group, which includes IBDs FSC Securities Corp., Royal Alliance Associates and SagePoint Financial.

Advisor Group is in conversations with a lot of those advisors who are looking for a new home, Roth says, and he believes the next year to 18 months will be a good window for recruiting. Today, the firm is working with more third-party recruiters than ever, has hired more experienced recruiters to its in-house team and has gotten more aggressive with its forgivable loan program.

“If they have a good practice, they're not interested in changing broker/dealers unless they have a reason,” Roth says. “So this gives them a reason.”

Most b/ds are not ruling these advisors out, but rather selectively looking at advisors from imploding firms with a more rigorous review of their product and business mix, said Matthew Bassuk, senior managing director of business development at First Allied. For example, First Allied brought on a QA3 group in California a couple of months ago that had minimal exposure to the private placements. After First Allied did a thorough evaluation of the group's business mix, the firm decided it was comfortable bringing the advisors on board.

Cambridge Investment Research executives echo Roth's comments, saying that all the recent b/d trouble represents a special opportunity for good b/ds. It creates an entirely new pool of potential recruits — advisors who rarely look for a new firm, such as those from SAI. If Cambridge can see that it was an honest mistake on the part of the rep and the firm can get comfortable that the rep has learned from it, “we'll take a chance with a lot of them,” says Kyle Selberg, senior vice president of business development. Already, the firm has recruited a number of QA3 and SAI advisors in the last few months.

There are a lot of strong advisors out there in the recruiting pool that wouldn't otherwise be looking, concurs Bill Van Law, head of recruiting for Raymond James Financial Services, who is also talking to some of these reps. “We look at it as a solid opportunity to get in front of some high quality advisors.”

The Sifting Process

But while the b/ds are willing and eager to find great talent among the wreckage, they will have to do their homework to find these diamonds in the rough, says industry consultant Tim Welsh, president of Nexus Strategy in Larkspur, Calif. “This will be a sifting process,” he says.

Financial Advisers of America has become extremely cautious about checking out the asset and sales mix of potential recruits, especially those advisors coming out of the imploding firms, says Pack. The firm has decided to avoid all reps who have product failures on their books, and the firm won't take on certain investments they're not comfortable with, even if they haven't gone bad yet. “In the end, the risk associated with certain transactions, albeit prior to FAA, is too significant and we don't want to expose the firm nor our current representatives to this potential risk,” Pack says.

Prospective employers have to ask the advisor why he or she is looking, and it's going to come up that the advisor's prior firm had these issues, says recruiter Danny Sarch of Leitner Sarch Consultants Ltd. in White Plains, N.Y. If the advisor did not sell the bad products, he will still have to prove it by providing a quarterly statement for every client, he adds. If the advisor did have exposure, the b/d will of course check out how much.

Brian Kovack, president of Kovack Securities, offers specifics: If an advisor sold the tainted products to five or fewer clients and has at least $500,000 in gross dealer concessions, he'll consider hiring that person to his firm. The more production an advisor has, the more he can shell out for defense costs if an arbitration or lawsuit does develop, Kovack reasons. Another way to manage the possible risk of litigation is to get the incoming clients to sign a disclosure agreement, he says.

“You need to be able to approach clients and have them sign a disclosure agreement recognizing that the new broker/dealer had no part in the sale of a tainted security at the prior firm,” says Kovack.

Meanwhile, Andrew Daniels, managing principal of recruiting and transition with Commonwealth Financial Network, says he's certainly happy to chat with reps from defunct firms as long as they have a clean record or the litigation is already settled.

Frying Pan to the Fire

Not only do the firms have to do their homework; the orphaned advisors do too. The last thing one of these FAs wants is to find himself in hot water again six months or more down the line.

“The biggest problem is when advisors look at that and say, ‘Oh my gosh, this ship is sinking. Let's get on the first boat that we can see,’” says Fusion's Palaveev. “And that results in just jumping from the frying pan into the fire.” For example, there were a lot of advisors that went from QA3 to Securities America, he says.

Jodie Papike, executive vice president of Cross-Search, a third-party recruiting firm, recommends FAs look at the firm's net capital and financials as well as their pending arbitrations before they make a move.

The smartest advisors will have shopped around for another b/d early in the process, as soon as they smelled trouble at the existing firm, says Alois Pirker, Aite Group analyst.

The Walking Dead?

Not all b/ds are open to taking on the orphaned advisors, especially those with a lot of troubled investments on their books. Cambridge is turning away a lot of advisors because of these issues, says Selberg. For example, the firm has talked to about one-fourth to one-third of QA3's rep base, but they've only brought on a handful of them. “They may be having a hard time finding a home they're comfortable with,” Selberg says.

Cambridge looks at reps on an individual basis, Selberg adds. If the rep was not involved with the problematic investments, has a good U4 and acceptable credit history, and is a good fit for the firm, they'll likely take on the rep. But if a rep did sell a problem product, Cambridge will review each sale in terms of suitability and the amount of exposure relative to the rep's total production, he added. Then, the firm will ask the rep several questions about his or her overall sales practices.

Kovack, who has also rejected a number of orphaned reps, says the most troubled of them will most likely have to go to newer, smaller firms that tend to be more aggressive with recruiting and are willing to take on more risk.

“I do believe if it's an advisor who does all his business in one or two product categories, aggressively sells these higher risk products, he's not going to be able to find a home in a big shop or quality firm,” says Advisor Group's Roth.

Some have even had a hard time finding third- and fourth-tier firms to take them on. Henschen had a rep at SAI who was promised a job with another b/d and quit SAI. But that turned out to be a bad move. “At the 11th hour, the broker/dealer said it had changed its mind and so he came to me,” Henschen says.

The rep tried to find other firms, but no one would take him; they didn't want the risk. He ended up having to do fixed insurance, cutting his yearly income by 86 percent. “It turned his life upside down,” Henschen says.

For those FAs who have just started out and haven't developed a large book of business, one potential path is to become a salaried advisor at a wirehouse firm with a call center model, says Pirker. These firms are trying to grow by the hundreds, and it allows the advisor to retain his securities licenses.

Abandoning the securities license altogether and becoming a registered investment advisor is another route some FAs may take. Many of the advisors from imploding firms that FAA rejected said, ‘I'm going to start my own RIA,’ says Todd Pack. This would be an easier transition for those reps who already do a lot of fee-based business because they wouldn't be giving up much of their income, says Henschen.

But your prior industry record is still subject to scrutiny by the SEC and the states when you become an RIA, says Palaveev. “For the sake of the industry, I hope that we don't see advisors with poor regulatory records establishing an RIA just so they can run away from their funeral record,” he says. “That's not good for anybody.”